Turning Bullish on Precious Metals

Gold's divergence since April was and still is troubling. Despite that divergence,
multiple different indicators are now signaling that the precious metal sector
could be at or approaching a major bottom. Though gold did break its uptrend
from October 2006, it has failed to breakdown in a manner that would deem significant
its recent underperformance. Another term for a breakdown that doesn't follow
through is "shakeout." The converse is when a breakout occurs but isn't sustained.

Let's start with sentiment. Weeks ago I posted a chart showing the total assets
in the Rydex Gold fund and the price of the fund. We could see that the assets
at that time, was considerably low given the price of the fund. Coincidentally,
that level of assets usually marked a key bottom for the fund's price. Here
is another measurement of sentiment:

The chart specifically highlights the put/call ratio for the options in the
XAU index. If a trader is bullish he'll buy calls. If he's bearish he will
buy puts. Thus, a high put/call ratio is evidence of bearish sentiment and
serves as a great contrary indicator. As you can see, the last time the put/call
ratio was in this territory, it was prior to the June 2006 bottom that produced
a very strong rebound over the next few weeks and months. The current put/call
ratio bodes well for a significant bottom to be in place.

Next, here is the current Commitment of Traders (COT) Report:

This report has been moving in the right direction if you are a gold bull.
The current data is similar to what we say at both the October and January
bottoms. These bottoms, respectively, produced a 16% and 15% rise in gold over
the following two months.

Now let's get to the technicals on gold. Here is a long-term weekly chart:

Currently, the lower 20-week lower band rests at $638, and the 65-week moving
average sits at $639. Throughout gold's bull market, it has yet to close below
both of the aforementioned gauges. Below that, sits the 20-month moving average
at $618 and the middle trendline at about $628. Essentially, we see major support
at $620 to $640.

Going forward, the single question is if that large support area holds up
or will gold need to decline further before it breaks to new highs? It is technically
possible that gold could decline to the $550-$575 area by the end of the year
and still remain in a bull market of course. However, it is obvious that the
majority of the evidence now sits in the favor of gold bulls.

What about gold lagging stocks and commodities? What about the newly exposed
problems with Collateralized Debt Obligations (CDO's)?

Gold is a leading indicator and its recent decline could be interpreted as
investors fearing a dryup in credit and liquidity. Credit and money growth
in the US has been quite high, though in the past few months, the pace of growth
has declined. However, as we have argued recently, it is precisely this kind
of environment that is best for precious metals. An environment of declining
to stagnant growth, declining growth in money and credit, and growing problems
with hedge funds ultimately leads to reflation. Many analysts have said that
gold will soar when the Fed tips its hand and cuts rates. Yes, and remember
that markets are forward thinking. Precious metals should begin their next
major advance before the Fed tips its hand.

That also portends to a falling dollar. The dollar's spring recovery has abated
and in the coming weeks, will once again threaten that key 80 level.

HUI & XAU Analysis follows for Trendsman readers....

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